Tài liệu Ten Principles of Economics - Part 37 doc

CHAPTER 16 OLIGOPOLY 371
Justice Department). Testifying for the government was a prominent economist
(MIT professor Franklin Fisher). Testifying for Microsoft was an equally promi-
nent economist (MIT professor Richard Schmalensee). At stake was the future
of one of the world’s most valuable companies (Microsoft) in one of the econ-
omy’s fastest growing industries (computer software).
A central issue in the Microsoft case involved tying—in particular, whether
Microsoft should be allowed to integrate its Internet browser into its Windows
operating system. The government claimed that Microsoft was bundling these
two products together to expand the market power it had in the market for
computer operating systems into an unrelated market (for Internet browsers).
Allowing Microsoft to incorporate such products into its operating system, the
government argued, would deter new software companies such as Netscape
from entering the market and offering new products.
Microsoft responded by pointing out that putting new features into old
products is a natural part of technological progress. Cars today include stereos
and air-conditioners, which were once sold separately, and cameras come with
built-in flashes. The same is true with operating systems. Over time, Microsoft
has added many features to Windows that were previously stand-alone prod-
ucts. This has made computers more reliable and easier to use because con-
sumers can be confident that the pieces work together. The integration of
Internet technology, Microsoft argued, was the natural next step.
One point of disagreement concerned the extent of Microsoft’s market
power. Noting that more than 80 percent of new personal computers used a
Microsoft operating system, the government argued that the company had sub-
stantial monopoly power, which it was trying to expand. Microsoft replied that
the software market is always changing and that Microsoft’s Windows was
constantly being challenged by competitors, such as the Apple Mac and Linux
operating systems. It also argued that the low price it charged for Windows—
about $50, or only 3 percent of the price of a typical computer—was evidence
that its market power was severely limited.

As this book was going to press, the final outcome of the Microsoft case was
yet to be resolved. In November 1999 the trial judge issued a ruling in which he
found that Microsoft had great monopoly power and that it had illegally abused
that power. But many questions were still unanswered. Would the trial court’s
decision hold up on appeal? If so, what remedy would the government seek?
Would it try to regulate future design changes in the Windows operating sys-
tem? Would it try to break up Microsoft into a group of smaller, more com-
petitive companies? The answers to these questions will shape the software
industry for years to come.
QUICK QUIZ: What kind of agreement is illegal for businesses to make?
◆ Why are the antitrust laws controversial?
CONCLUSION
Oligopolies would like to act like monopolies, but self-interest drives them closer
to competition. Thus, oligopolies can end up looking either more like monopolies
or more like competitive markets, depending on the number of firms in the
“ME? A MONOPOLIST? NOW JUST WAIT A
MINUTE
. . .”
372 PART FIVE FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
oligopoly and how cooperative the firms are. The story of the prisoners’ dilemma
shows why oligopolies can fail to maintain cooperation, even when cooperation is
in their best interest.
Policymakers regulate the behavior of oligopolists through the antitrust laws.
The proper scope of these laws is the subject of ongoing controversy. Although
price fixing among competing firms clearly reduces economic welfare and should
be illegal, some business practices that appear to reduce competition may have le-
gitimate if subtle purposes. As a result, policymakers need to be careful when they
use the substantial powers of the antitrust laws to place limits on firm behavior.
◆ Oligopolists maximize their total profits by forming a
cartel and acting like a monopolist. Yet, if oligopolists

make decisions about production levels individually, the
result is a greater quantity and a lower price than under
the monopoly outcome. The larger the number of firms
in the oligopoly, the closer the quantity and price will be
to the levels that would prevail under competition.
◆ The prisoners’ dilemma shows that self-interest can
prevent people from maintaining cooperation, even
when cooperation is in their mutual interest. The logic
of the prisoners’ dilemma applies in many situations,
including arms races, advertising, common-resource
problems, and oligopolies.
◆ Policymakers use the antitrust laws to prevent
oligopolies from engaging in behavior that reduces
competition. The application of these laws can be
controversial, because some behavior that may seem to
reduce competition may in fact have legitimate business
purposes.
Summary
oligopoly, p. 350
monopolistic competition, p. 350
collusion, p. 353
cartel, p. 353
Nash equilibrium, p. 355
game theory, p. 358
prisoners’ dilemma, p. 359
dominant strategy, p. 360
Key Concepts
1. If a group of sellers could form a cartel, what quantity
and price would they try to set?
2. Compare the quantity and price of an oligopoly to those

of a monopoly.
3. Compare the quantity and price of an oligopoly to those
of a competitive market.
4. How does the number of firms in an oligopoly affect the
outcome in its market?
5. What is the prisoners’ dilemma, and what does it have
to do with oligopoly?
6. Give two examples other than oligopoly to show how
the prisoners’ dilemma helps to explain behavior.
7. What kinds of behavior do the antitrust laws prohibit?
8. What is resale price maintenance, and why is it
controversial?
Questions for Review
CHAPTER 16 OLIGOPOLY 373
1. The New York Times (Nov. 30, 1993) reported that “the
inability of OPEC to agree last week to cut production
has sent the oil market into turmoil . . . [leading to] the
lowest price for domestic crude oil since June 1990.”
a. Why were the members of OPEC trying to agree to
cut production?
b. Why do you suppose OPEC was unable to agree on
cutting production? Why did the oil market go into
“turmoil” as a result?
c. The newspaper also noted OPEC’s view “that
producing nations outside the organization, like
Norway and Britain, should do their share and cut
production.” What does the phrase “do their share”
suggest about OPEC’s desired relationship with
Norway and Britain?
2. A large share of the world supply of diamonds comes

from Russia and South Africa. Suppose that the
marginal cost of mining diamonds is constant at $1,000
per diamond, and the demand for diamonds is
described by the following schedule:
PRICE QUANTITY
$8,000 5,000
7,000 6,000
6,000 7,000
5,000 8,000
4,000 9,000
3,000 10,000
2,000 11,000
1,000 12,000
a. If there were many suppliers of diamonds, what
would be the price and quantity?
b. If there were only one supplier of diamonds, what
would be the price and quantity?
c. If Russia and South Africa formed a cartel, what
would be the price and quantity? If the countries
split the market evenly, what would be South
Africa’s production and profit? What would
happen to South Africa’s profit if it increased its
production by 1,000 while Russia stuck to the cartel
agreement?
d. Use your answer to part (c) to explain why cartel
agreements are often not successful.
3. This chapter discusses companies that are oligopolists in
the market for the goods they sell. Many of the same
ideas apply to companies that are oligopolists in the
market for the inputs they buy.

a. If sellers who are oligopolists try to increase the
price of goods they sell, what is the goal of buyers
who are oligopolists?
b. Major league baseball team owners have an
oligopoly in the market for baseball players. What
is the owners’ goal regarding players’ salaries?
Why is this goal difficult to achieve?
c. Baseball players went on strike in 1994 because
they would not accept the salary cap that the
owners wanted to impose. If the owners were
already colluding over salaries, why did the owners
feel the need for a salary cap?
4. Describe several activities in your life in which game
theory could be useful. What is the common link among
these activities?
5. Consider trade relations between the United States and
Mexico. Assume that the leaders of the two countries
believe the payoffs to alternative trade policies are as
follows:
a. What is the dominant strategy for the United
States? For Mexico? Explain.
b. Define Nash equilibrium. What is the Nash
equilibrium for trade policy?
c. In 1993 the U.S. Congress ratified the North
American Free Trade Agreement (NAFTA), in
which the United States and Mexico agreed to
reduce trade barriers simultaneously. Do the
perceived payoffs as shown here justify this
approach to trade policy?
d. Based on your understanding of the gains from

trade (discussed in Chapters 3 and 9), do you think
that these payoffs actually reflect a nation’s welfare
under the four possible outcomes?
United States Decision
Low
Tariffs
Low Tariffs
U.S. gains
$25 billion
Mexico gains
$25 billion
Mexico gains
$10 billion
Mexico gains
$30 billion
Mexico gains
$20 billion
U.S. gains
$30 billion
U.S. gains
$10 billion
U.S. gains
$20 billion
High Tariffs
High
Tarrifs
Mexico's
Decision
'
Problems and Applications

374 PART FIVE FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
6. Suppose that you and a classmate are assigned a project
on which you will receive one combined grade. You
each want to receive a good grade, but you also want to
do as little work as possible. The decision box and
payoffs are as follows:
Assume that having fun is your normal state, but
having no fun is as unpleasant as receiving a grade that
is two letters lower.
a. Write out the decision box that combines the letter
grade and the amount of fun you have into a single
payoff for each outcome.
b. If neither you nor your classmate knows how much
work the other person is doing, what is the likely
outcome? Does it matter whether you are likely to
work with this person again? Explain your answer.
7. The chapter states that the ban on cigarette advertising
on television in 1971 increased the profits of cigarette
companies. Could the ban still be good public policy?
Explain your answer.
8. A case study in the chapter describes a phone
conversation between the presidents of American
Airlines and Braniff Airways. Let’s analyze the game
between the two companies. Suppose that each
company can charge either a high price for tickets or a
low price. If one company charges $100, it earns low
profits if the other company charges $100 also, and high
profits if the other company charges $200. On the other
hand, if the company charges $200, it earns very low
profits if the other company charges $100, and medium

profits if the other company charges $200 also.
a. Draw the decision box for this game.
b. What is the Nash equilibrium in this game?
Explain.
c. Is there an outcome that would be better than
the Nash equilibrium for both airlines? How
could it be achieved? Who would lose if it were
achieved?
9. Farmer Jones and Farmer Smith graze their cattle on
the same field. If there are 20 cows grazing in the
field, each cow produces $4,000 of milk over its
lifetime. If there are more cows in the field, then each
cow can eat less grass, and its milk production falls.
With 30 cows on the field, each produces $3,000 of milk;
with 40 cows, each produces $2,000 of milk. Cows cost
$1,000 apiece.
a. Assume that Farmer Jones and Farmer Smith can
each purchase either 10 or 20 cows, but that neither
knows how many the other is buying when she
makes her purchase. Calculate the payoffs of each
outcome.
b. What is the likely outcome of this game? What
would be the best outcome? Explain.
c. There used to be more common fields than there are
today. Why? (For more discussion of this topic,
reread Chapter 11.)
10. Little Kona is a small coffee company that is considering
entering a market dominated by Big Brew. Each
company’s profit depends on whether Little Kona
enters and whether Big Brew sets a high price or a low

price:
Big Brew threatens Little Kona by saying, “If you enter,
we’re going to set a low price, so you had better stay
out.” Do you think Little Kona should believe the
threat? Why or why not? What do you think Little Kona
should do?
11. Jeff and Steve are playing tennis. Every point comes
down to whether Steve guesses correctly whether
Jeff will hit the ball to Steve’s left or right. The
outcomes are:
Big Brew
Enter
High Price
Brew makes
$3 million
Kona makes
$2 million
Kona loses
$1 million
Kona makes
zero
Kona makes
zero
Brew makes
$1 million
Brew makes
$7 million
Brew makes
$2 million
Low Price

Don't
Enter
Little
Kona
Your Decision
Work
Work
You get A grade,
no fun
Classmate gets
A grade, no fun
Classmate gets B
grade, no fun
Classmate gets
B grade, fun
Classmate gets
D grade, fun
You get B grade,
fun
You get B grade,
no fun
You get D grade,
fun
Shirk
Shirk
Classmate's
Decision
CHAPTER 16 OLIGOPOLY 375
Does either player have a dominant strategy? If Jeff
chooses a particular strategy (Left or Right) and sticks

with it, what will Steve do? So, can you think of a better
strategy for Jeff to follow?
Steve Guesses
Left
Left
Steve wins
point
Jeff wins
point
Jeff wins
point
Steve wins
point
Right
Right
Jeff
Hits
Jeff loses
point
Steve loses
point
Steve loses
point
Jeff loses
point

IN THIS CHAPTER
YOU WILL . . .
Examine the debate
over the role of

brand names
Consider the
desirability of
outcomes in
monopolistically
competitive
markets
Analyze competition
among firms that
sell differentiated
products
Compare the
outcome under
monopolistic
competition and
under perfect
competition
Examine the debate
over the effects of
advertising
You walk into a bookstore to buy a book to read during your next vacation. On the
store’s shelves you find a John Grisham mystery, a Stephen King thriller, a Danielle
Steel romance, a Frank McCourt memoir, and many other choices. When you pick
out a book and buy it, what kind of market are you participating in?
On the one hand, the market for books seems competitive. As you look over
the shelves at your bookstore, you find many authors and many publishers vying
for your attention. A buyer in this market has thousands of competing products
from which to choose. And because anyone can enter the industry by writing and
publishing a book, the book business is not very profitable. For every highly paid
novelist, there are hundreds of struggling ones.

On the other hand, the market for books seems monopolistic. Because each
book is unique, publishers have some latitude in choosing what price to charge.
The sellers in this market are price makers rather than price takers. And, indeed,
the price of books greatly exceeds marginal cost. The price of a typical hardcover
MONOPOLISTIC COMPETITION
377
378 PART FIVE FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
novel, for instance, is about $25, whereas the cost of printing one additional copy
of the novel is less than $5.
In this chapter we examine markets that have some features of competi-
tion and some features of monopoly. This market structure is called monopolistic
competition. Monopolistic competition describes a market with the following
attributes:
◆ Many sellers: There are many firms competing for the same group of
customers.
◆ Product differentiation: Each firm produces a product that is at least slightly
different from those of other firms. Thus, rather than being a price taker, each
firm faces a downward-sloping demand curve.
◆ Free entry: Firms can enter (or exit) the market without restriction. Thus,
the number of firms in the market adjusts until economic profits are driven
to zero.
A moment’s thought reveals a long list of markets with these attributes: books,
CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, and
so on.
Monopolistic competition, like oligopoly, is a market structure that lies be-
tween the extreme cases of competition and monopoly. But oligopoly and monop-
olistic competition are quite different. Oligopoly departs from the perfectly
competitive ideal of Chapter 14 because there are only a few sellers in the market.
The small number of sellers makes rigorous competition less likely, and it makes
strategic interactions among them vitally important. By contrast, under monopo-

listic competition, there are many sellers, each of which is small compared to the
market. A monopolistically competitive market departs from the perfectly com-
petitive ideal because each of the sellers offers a somewhat different product.
COMPETITION WITH DIFFERENTIATED PRODUCTS
To understand monopolistically competitive markets, we first consider the de-
cisions facing an individual firm. We then examine what happens in the long
run as firms enter and exit the industry. Next, we compare the equilibrium un-
der monopolistic competition to the equilibrium under perfect competition that
we examined in Chapter 14. Finally, we consider whether the outcome in a mo-
nopolistically competitive market is desirable from the standpoint of society as a
whole.
THE MONOPOLISTICALLY COMPETITIVE
FIRM IN THE SHORT RUN
Each firm in a monopolistically competitive market is, in many ways, like a mo-
nopoly. Because its product is different from those offered by other firms, it faces a
monopolistic competition
a market structure in which many
firms sell products that are similar
but not identical
CHAPTER 17 MONOPOLISTIC COMPETITION 379
downward-sloping demand curve. (By contrast, a perfectly competitive firm faces
a horizontal demand curve at the market price.) Thus, the monopolistically com-
petitive firm follows a monopolist’s rule for profit maximization: It chooses the
quantity at which marginal revenue equals marginal cost and then uses its de-
mand curve to find the price consistent with that quantity.
Figure 17-1 shows the cost, demand, and marginal-revenue curves for two
typical firms, each in a different monopolistically competitive industry. In both
panels of this figure, the profit-maximizing quantity is found at the intersection of
the marginal-revenue and marginal-cost curves. The two panels in this figure
show different outcomes for the firm’s profit. In panel (a), price exceeds average

total cost, so the firm makes a profit. In panel (b), price is below average total cost.
In this case, the firm is unable to make a positive profit, so the best the firm can do
is to minimize its losses.
All this should seem familiar. A monopolistically competitive firm chooses its
quantity and price just as a monopoly does. In the short run, these two types of
market structure are similar.
THE LONG-RUN EQUILIBRIUM
The situations depicted in Figure 17-1 do not last long. When firms are mak-
ing profits, as in panel (a), new firms have an incentive to enter the market. This
QuantityProfit-
maximizing
quantity
Loss-
minimizing
quantity
0
Price
Price
Demand
Demand
MR
ATC
(a) Firm Makes Profit
Quantity0
Price
Price
Average
total cost
Average
total cost

(b) Firm Makes Losses
MR
Profit
Losses
MC
ATC
MC
Figure 17-1
MONOPOLISTIC COMPETITORS IN THE SHORT RUN. Monopolistic competitors, like
monopolists, maximize profit by producing the quantity at which marginal revenue
equals marginal cost. The firm in panel (a) makes a profit because, at this quantity, price is
above average total cost. The firm in panel (b) makes losses because, at this quantity, price
is less than average total cost.
380 PART FIVE FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
entry increases the number of products from which customers can choose and,
therefore, reduces the demand faced by each firm already in the market. In other
words, profit encourages entry, and entry shifts the demand curves faced by the
incumbent firms to the left. As the demand for incumbent firms’ products falls,
these firms experience declining profit.
Conversely, when firms are making losses, as in panel (b), firms in the market
have an incentive to exit. As firms exit, customers have fewer products from which
to choose. This decrease in the number of firms expands the demand faced by
those firms that stay in the market. In other words, losses encourage exit, and exit
shifts the demand curves of the remaining firms to the right. As the demand for
the remaining firms’ products rises, these firms experience rising profit (that is, de-
clining losses).
This process of entry and exit continues until the firms in the market are mak-
ing exactly zero economic profit. Figure 17-2 depicts the long-run equilibrium.
Once the market reaches this equilibrium, new firms have no incentive to enter,
and existing firms have no incentive to exit.

Notice that the demand curve in this figure just barely touches the average-
total-cost curve. Mathematically, we say the two curves are tangent to each other.
These two curves must be tangent once entry and exit have driven profit to zero.
Because profit per unit sold is the difference between price (found on the demand
curve) and average total cost, the maximum profit is zero only if these two curves
touch each other without crossing.